A goal among many leaders in Kentucky is to
see the states per capita income equal or exceed the national per capita income
average. Although Kentucky has narrowed the income gap recently, its per capita income
still stands at only 81 percent of the national average. Matching this national level
would require significant changes in Kentucky. The state would need large increases in the
number of high school and college graduates in the state, and/or in the percentage of
private sector employment per capita. Based on previous rates of increase, it will still
be many years before Kentuckys per capita income is equal to the national average.

Introduction

A frequently used indicator of a states economic health is per
capita income. Historically, Kentuckys per capita income has been below that of the
U.S. average, although that gap has narrowed in recent years. In 1995, per capita income
in the U.S. stood at $23,208 in 1995 while in Kentucky the level was $18,849.

1 Many believe that an important goal for Kentucky is
to narrow the gap between its income and that of the rest of the country. Kentucky
Governor Paul Patton, in a recent speech to the Hopkinsville Chamber of Commerce, said
that his goal was to see per capita income in Kentucky above the national average.2 Although this may be a lofty goal, there is cause
for optimism given the recent history of income levels in Kentucky. Indeed, while per
capita income in Kentucky stood at only 78.3 percent of the national average in 1985, by
1995 it had increased steadily to 81.2 percent of the national average.

In this article, I examine long-term trends in Kentuckys per
capita income relative to the national average. In the process, I address several
questions: 1) Has the recent increase in Kentuckys per capita income relative to the
U.S. average been part of a long-term increase or has it been confined to more recent
years? 2) Has Kentuckys experience mirrored that of other states, or has it been
unique? 3) What determines differences in per capita income at the state level? 4) Can
these determinants explain why Kentuckys per capita income is below the national
average? 5) What can explain the increase in Kentuckys per capita income relative to
the national average in recent years? 6) How different would Kentucky have to be today to
be at the national average of per capita income? 7) How long will it take for Kentucky to
reach the national average per capita income?

Per Capita Income as a
Measure of Well-Being or Standard of Living

Per capita income is often used by policymakers and the
public as an overall index of well-being or standard of living in an economy. Thus, before
proceeding with the analysis, it is important to examine what per capita income measures
and to look at its strengths and weaknesses as an indicator of economic well-being.

Personal income data are collected by the U.S. Department of
Commerces Bureau of Economic Analysis as part of the National Income and Product
Accounts. These data comprise wage and salary disbursements, other labor income,
proprietors income, rental income of persons, personal dividend income, personal
interest income, and transfer payments to persons (e.g., Social Security, Aid to Families
with Dependent Children, etc.). The majority of personal income comprises wage and salary
disbursements, followed by transfer payments to persons and personal interest income.
Table 1 shows the 1995 breakdown of personal income into its components for the U.S. and
Kentucky.

TABLE 1
Personal Income and Its Components, U.S. and Kentucky, 1995

Kentucky1

U.S.2

Amount Percent

Amount Percent

Wage and salary disbursements

40,644,369

86%

3,423,330

85%

Other labor income

5,476,497

12

423,799

11

Farm
proprietors income

5,282,519

11

19,529

0

Nonfarm proprietors income

623,446

1

449,257

11

Less:
contributions for social insurance

-3,650,670

-8

-294,013

-7

Less: adjustment for residence

-250,831

-1

-873

-0.02

Net
earnings by place of residence

47,501,884

65

4,021,029

66

Dividends, interest, rent

10,879,281

15

1,054,107

17

Transfer
payments

14,380,955

20

1,022,841

17

Total personal income

72,762,120

100

6,097,977

100

Population
(000s)

3,860

262,755

Per capita income (dollars)

$18,849

$23,208

1 In thousands of dollars unless otherwise noted.

2 In millions of dollars unless otherwise noted.

Source: U.S. Department of Commerce, Bureau of Economic Analysis,

Thus, personal income is just the total amount of income
earned or disbursed to individuals in the economy in one form or another in a given year.
Individuals then use this personal income to purchase goods and services, pay taxes, or
place in savings or investments. It is thus a broad-based measure of economic well-being
for the economy. Per capita personal income is simply the total personal income
divided by the total population, which gives a per person measure of the income earned or
disbursed to individuals in the economy. As a result, per capita income adjusts for
population differences over time or across states.

The chief limitation of personal income as a measure of well-being is
that it does not measure activities or things that people value that are not traded in the
marketplace. For example, environmental quality or other amenities are not reflected in
personal income, nor is the value of leisure time or the value of services provided inside
the household. Nevertheless, personal income covers a broad base of economic measures
better than any other indicator. For instance, another indicator such as the unemployment
rate only gives the percentage of persons without work, not the well-being of those with
work. Similarly, the employment rate tells the percentage of persons that are working but
not the earnings of those workers. On the other hand, average wages would provide the
earnings of workers but not the income non-workers have at their disposal. Consequently,
personal income is the best measure of economic well-being that is readily available.

Per Capita Income in
Kentucky Relative to the U.S.

Figure 1 shows the ratio of per capita income in
Kentucky to the U.S. average from 1929 to 1995, the entire time period for which per
capita income data are available from the National Income and Product Accounts. Two series
are shown in Figure 1: the first spans the period from 192994, and the second shows
the new series recently published by the Bureau of Economic Analysis that covers the
period from 196995 but is not comparable to the earlier series.3

Figure 1 tells an interesting story. Per capita income in Kentucky
relative to the U.S. average rose steadily until about 1979 or 1980, exhibiting the
long-run convergence familiar to regional and growth economists. For instance, Barro and
Sala-i-Martin argue that marginal returns to capital may be higher in states with low
income levels, and thus growth may be higher, promoting convergence.4 Convergence may also occur if there is mobility of
businesses and workers across states. Businesses will tend to migrate where land and labor
costs are lower, expanding economic activity and raising per capita income. In contrast,
workers will tend to migrate where wages are higher, increasing the supply of workers in
certain areas and exerting downward pressure on income. The net effect of such mobility
would be an equalizing of incomes across states and higher rates of growth in per capita
income observed in low income states.5

In the long run, with such mobility of businesses and workers, incomes
would be completely equalized across states except for differences reflecting
location-specific factors. Blomquist, Berger, and Hoehn examine such differences due to
location-specific amenities such as climate, air and water quality, and other natural
conditions.6 For example, if people
find Kentucky to be a pleasant place to live because of its climate or natural features
such as rivers or mountains, then per capita incomes may remain below the national
average; in other words, Kentucky residents are willing to accept a lower income to live
in a desirable location. Per capita incomes in undesirable locations would lie above the
national average to compensate individuals for living in unpleasant conditions.
Nonetheless, excepting location-specific amenities, both growth theories and regional
models of economic behavior predict an eventual convergence of per capita income for
Kentucky and the U.S.

Contrary to the long-run pattern of convergence, however,
Kentuckys relative per capita income fell rather sharply in the early and middle
1980s. This fact suggests that the recession and economic restructuring of that period
affected income in Kentucky more than in the rest of the country.7 Since about 1985, though, Kentuckys per
capita income has been rising relative to the national average, so that the states
relative income now stands approximately at its 197980 level. Viewed in this light,
the recent increase in Kentuckys income has represented a catching up to a level
relative to the national average that had been reached previously.

What will the future hold and how quickly can we expect Kentuckys
per capita income to converge to the national average? We can get some clues about the
process of convergence by looking at the experiences of other states. I turn to this
analysis in the next section.

Kentuckys
Experience Compared to Other States

Has this convergence to the national per capita income
average been unique to Kentucky, or has it occurred in other states? Table 2 shows that
convergence has been proceeding on a nationwide basis regardless if considering the entire
period of available data (192994) or the last 10 years. This table shows the average
change in the ratio of state to U.S. per capita income, both for those states that began
each time period above the national average and those that began below the national
average. As would be expected from convergence, the average change for those states above
the average is negative and positive for those below the average. States like Kentucky
that are below the national average are catching up over time and those above the national
average are falling toward it. Figure 2 focuses on the experience of Kentucky and
surrounding states over the last 10 years. It shows that the pattern of convergence to the
national average has also occurred in states neighboring Kentucky.

TABLE 2
Convergence of States Per Capita Income to
U.S. Average, 192994 and 198595

Time
Period

Number
of States

Average
Change in Relative Income

States above U.S. average, 1929

192994

14

-0.1780

States below U.S. average, 1929

192994

34

0.1825

States
above U.S. average, 1985

198595

17

0.0004

States below U.S. average, 1985

198595

33

0.0092

Source: U.S. Department of Commerce, Bureau of

Economic Analysis, unpublished data.

As Kentuckys relative income has risen, has its per capita income
ranking among the states changed? Figure 2 shows that there has been no change in rankings
over the last 10 years among surrounding states. Table 3 shows the top 10 and bottom 10
states in per capita income rankings in 1985 and 1995, expressed in terms of income
relative to the U.S. average. Table 3 shows that even though convergence to the national
average has been occurring, the state rankings change slowly. Kentucky was ranked 44th in
per capita income in 1985, and after 10 years of convergence, it had only moved up to 43rd
by 1995.

TABLE 3
Top 10 and Bottom 10 States Ranked by Personal Per Capita Income (PCI)
Relative to U.S. Average, 1985 and 1995

On the most basic level, factors that affect per capita
income are those which raise or lower the amount of income a person receives in a state.
One such set include factors which raise or lower the productivity of the labor force.
Most obvious among these is the level of education. Workers in states with higher levels
of education among their residents will earn more in the labor market and thus increase
those states per capita income. Not only productivity, but employment of workers in
general will be a very important factor affecting per capita income across states. States
with a higher percentage of their population working will have more people earning wages
and salaries and thus are likely to have a higher per capita income. In addition, whether
the state is primarily urban or rural will have an impact on the model. Rural states will
have a disproportionate number of individuals working in agriculture, where wages and
incomes will tend to be lower. Thus, the very nature of the jobs in rural states will tend
to hold down per capita incomes.

I have constructed an econometric model of per capita income that
explains variation in income across states in 1995. After experimenting with several
different combinations of variables which account for the factors discussed in the
previous paragraph, I have specified five variables that do a good job in explaining
differences in per capita income across states.8 Table 4 shows these variables and the results of the estimated econometric
model. This table also shows the average values of the variables across all the states and
the Kentucky values of the variables which will help explain why Kentuckys income is
below the national average.

TABLE 4
Econometric Estimates Explaining Per Capita
Income by State, 1995 a

Estimated

Kentucky

Average

Variable

effect
b

value

of states

% of population over 25 & high school graduate

0.0096 *

31.7

30.9

% of population over 25 & college graduate

0.0208 *

13.6

20.

0

Private
sector employment per capita

0.7679 *

0.4361

0.486

Public sector employment per capita

-0.4528

0.0832

0.0965

%
of population living in rural areas

-0.0039 *

48.1

31.1

Intercept

9.0830 *





Log
of per capita personal income



9.844

10.

00

a
The dependent variable is the natural log of per capita personal income. Fifty-one
observations (including the District of Columbia) were used in the analysis. The R2 for
the estimated model is 0.7615.

b A * denotes statistical significance
at the 5 percent level in a two-tailed test.

Source: U.S. Department of Commerce, Bureau of
EconomicAnalysis, unpublished data.

From these econometric estimates, the following
conclusions can be drawn about the determinants of per capita income across states: States
with higher education levels, as measured by the percentages of the population over age 25
that are high school and college graduates, have higher per capita incomes. States with
higher private sector employment per capita also have higher income per capita.
Interestingly, states with higher government employment per capita, holding other
variables constant, have lower per capita income. This finding suggests that improvements
in per capita income are more likely to be obtained if job growth comes from the private
rather than the public sector. Finally, as expected, states with higher rural populations
have lower per capita incomes.

Why is Kentuckys Per
Capita Income Below the National Average?

The results of the econometric model can be used to
explain why Kentuckys per capita income level is below that of the average across
all states. This is done by calculating the differences in the predicted per capita
incomes arising from differences in education levels, employment per capita, and the
percentage of population that is rural between Kentucky and the U.S. Figure 3 shows this
calculation. We see that 57 percent of the difference between Kentuckys predicted
per capita income and the predicted average of the states per capita incomes is due
to education differences  primarily Kentuckys low percentage of college
graduates among the population age 25 and over. That Kentucky is a much more rural state
than average accounts for 29 percent of the difference, and the remaining 14 percent comes
from the fact that Kentuckys employment per capita is lower than the average of the
rest of the states.

Thus, the lions share of the difference arises from the lower
education levels in Kentucky compared to the average of other states. If education levels
were higher, Kentuckys per capita income would be closer to the national average. In
fact, the model suggests that if Kentuckys education levels were equal to the
national average, 57 percent of the gap between Kentuckys per capita income and the
national average per capita income could be closed.

Kentuckys Per
Capita Income from 1985 to 1995

In considering why Kentuckys per capita income has
risen relative to the rest of the country from 1985 to 1995, we need to look for trends in
Kentucky that are different from the rest of the country. Education levels have been
improving over time both in Kentucky and in the rest of the country, so education cannot
explain the rising per capita income in Kentucky. Similarly, there has been a small
decline in the percentage of the population living in rural areas in both Kentucky and the
rest of the country. That leaves employment/population changes.

While the recession of the early 1980s was particularly hard on
Kentucky, the opposite was true for the recession of the early 1990s. Kentucky barely felt
that recession, and since then, job growth has been stronger in Kentucky than in many
other places. At the same time, population growth in Kentucky has not been as strong as in
the rest of the country. These two factors combined imply that employment per capita has
been rising faster in Kentucky than in the rest of the country. Figure 4 shows the changes
in private employment per capita in Kentucky and for the U.S. From this figure it is
apparent that private employment per capita has been increasing faster in Kentucky than in
the rest of the country, and this difference may be partially responsible for the relative
gain in Kentucky per capita income from 198595. This employment growth has in part
contributed to the resumption in the convergence of Kentuckys per capita income to
the U.S. average so that it is now back to the level it was before the recession of the
late 1970s and early 1980s.

Making Them Equal

We can use the results of our econometric model to
construct scenarios under which Kentuckys per capita income would be equal to the
U.S. per capita income. We must ask how different Kentuckys characteristics must be
for the states per capita income to be equal or greater than the U.S. average. In
Table 5, I consider three different scenarios that might accomplish this goal. The first
scenario increases Kentuckys education levels until the predicted per capita income
from the model matches the national average. Under this scenario, Kentucky would have the
same number of jobs, but its workers would be more educated and hence more productive, all
of which would raise incomes. The second scenario increases private sector employment per
capita, increasing the number of jobs while holding education levels constant. More jobs
might exist because there are more employers in the state, or labor force participation
rates, which are lower in Kentucky than in most other states, might rise. In the third
scenario both education levels and private sector employment per capita are raised. All
three scenarios hold constant the percentage of the population living in rural areas and
the number of government jobs per capita.

TABLE 5
Changes in Kentuckys Education Levels and Employment Required
for Per Capital Personal Income to be Equal to or Greater than U.S. Average, 1995

Characteristic

Scenario 1

Scenario 2

Scenario 3

% of population 25 and over & high school graduate

20%



10%

% of population 25 and over & college graduate

50%



25%

Private
sector employment per capita



60%

30%

Source: Calculated from results shown in Table 4.

Scenario 1 means Kentucky would have a 50 percent higher percentage of
the population age 25 and over with a bachelors degree or higher and a 20 percent
higher percentage of high school graduates. Kentucky would then lie almost exactly at the
average of the other states for the percentage of college graduates (20.4 percent vs. 20.3
percent) and well above the average of the other states for the percentage of the
population that are high school graduates that did not attend college (38.0 percent vs.
30.9 percent). In fact, such a 20 percent increase in the percentage of the population
that are high school graduates only would place Kentucky ahead of all other states,
including Pennsylvania, where 38.7 percent of the population age 25 and over are high
school graduates.

Scenario 2 would correspond to a 60 percent increase in the number
of private sector jobs per capita. This would put Kentucky far above the average of the
other states. In fact, only the District of Columbia would have a higher number of private
sector jobs per capita and many of its jobs are held by commuters who do not live in the
District.

Scenario 3 corresponds to increases in education levels and private
sector employment per capita that are half the sizes of those in Scenarios 1 and 2. Such a
combination of characteristics would give Kentucky a percentage of high school graduates
similar to Nebraska and Vermont, a percentage of college graduates the same as Wisconsin
and Idaho, and a private sector employment per capita similar to Nevada and Colorado. In
general, the scenarios show that, to have a per capita income level equal to the national
average at present, Kentucky would need a far different economy and a much more educated
workforce.

How Long Will it Take?

Following the scenarios presented above, Kentucky would
require a long time to catch up to the average U.S. per capita income. It might take a
generation to raise education levels as much as needed, and, if education levels were
rising at the same rate in the rest of the country as well, per capita income in Kentucky
would not rise at all relative to the national average. On the other hand, the process of
regional convergence, where capital and labor flow to areas with the highest return,
should naturally raise per capita income in Kentucky relative to the rest of the country,
as it has done in the past.

How soon should we reasonably expect this convergence? Looking at the
long-term trends in Kentuckys per capita income relative to the U.S. average, we can
see that it took over 30 years to increase Kentuckys relative per capita income from
approximately 60 percent to 80 percent of the national average. To obtain more precise
estimates of the rate of convergence, I have estimated regression models of
Kentuckys relative per capita income over various time periods and reported the
results in Table 6. As can be seen the estimates range from a predicted increase of 0.0045
per year (0.45 percent) over the entire 192994 time period of the old series to
0.0060 (0.60 percent) per year estimated from 192979. These estimates can be used to
predict how long it will take Kentucky to move from its current level of 81.2 percent of
U.S. per capita income to 100 percent of the U.S. level. Using the highest estimated rate
of convergence (0.60 percent), Kentucky will catch up to the national average in 31 years
and will reach 90 percent of the national average in 15 years.

TABLE 6
Estimated Rates of Convergence and Number of Years until Kentucky
Per Capita Income Equals U.S. Average Per Capita Income

Time period of estimation

Estimated annual convergence rate

Number of years until equality reached

Number of years until 90% of U.S. average reached

192994

0.45%

42

20

192979

0.60%

31

15

198695

0.51%

37

17

Source: Calculated using U.S. Department of Commerce, Bureau of Economic Analysis
unpublished data.

Using any of the three estimates, it is clear that the
convergence of Kentuckys per capita income to the national average is a long-run
process and difficult to accomplish overnight. Even if Kentucky were to increase the
highest estimated long-run rate of convergence by 50 percent, it would still take 21 years
for the state to reach the national average level of per capita income.

Conclusion

Will Kentucky in fact reach this national average? Probably, given the
progression toward convergence that has been and is still occurring in the U.S. Of course,
if Kentucky is a desirable place to live and work, it may never completely reach the
national average because residents will accept lower incomes to live here. Based on past
trends of convergence, it will take many years for Kentuckys per capita income to
reach the national average. The process could be accelerated, but it would be difficult.
It would require that education levels or jobs grow faster than the national average,
which may be difficult for Kentucky to sustain.

Footnotes

U.S. Department of Commerce, Bureau of Economic Analysis,
Total Personal Income and Earnings by Industry (SA05) 1969-1995, unpublished
data files, September 1996.

Governor Paul Pattons speech to the Hopkinsville
Chamber of Commerce, July 23, 1996. Source: Office of the Governor Press Office, September
3, 1996.

U.S. Department of Commerce, Bureau of Economic Analysis,
Total and Per Capita Personal Income by State and Region, Survey of Current
Business 76 (May 1996): 94-101.

These and other reasons for convergence are discussed in
Edward Nissan and George Carter, Income Inequality Across Regions Over Time,
Growth and Change 24 (Summer 1993): 303-320, and Rajiv Mallick, Convergence of State
Per Capita Incomes: An Examination of Its Sources, Growth and Change 24 (Summer
1993): 321-340.

James S. Fackler, Economic Overview: National and
State Economic Activity, Kentucky Annual Economic Report, University of Kentucky
Center for Business and Economic Research (1995): 43-48.

I also tried to add other variables to the model, but
with the five variables already included, these variables were not statistically
significant. Most notable among these were variables measuring the age distribution of the
population, such as the percentage of the population under age 18 and the percentage over
age 65.